Treasurys rally on cooling housing, tame inflation

LeslieWines

NEW YORK (MarketWatch) -- Treasury prices closed with sharp gains Tuesday, pressing yields lower after an unexpectedly tame producer price report and new evidence that the residential real estate market is continuing to worsen.

The latest reports take more pressure off the Federal Reserve to tighten interest rates when it holds its monetary policy meeting on Wednesday.

The rally was reinforced by safe-haven flows after news that the Thai military staged a coup against Prime Minister Thaksin Shinawatra.

The benchmark 10-year Treasury note closed up 19/32 at 101-3/32 with a yield
TNX, -0.07%
of 4.735%, down from 4.808% in late trade on Tuesday. Prices and yields move in opposite directions.

The 2-year note rose 4/32 to 100-4/32 with a yield of 4.805% as the 5-year note gained 11/32 to 99-23/32, yielding 4.692%.

The 30-year long bond jumped a full point higher to close at 94-13/32 with a 4.860% yield
TYX, -0.10%

Prices opened unchanged but bolted higher after the Labor Department reported that producer prices increased by just 0.1% in August, contrasting with expectations for a 0.3% set by economists polled by MarketWatch. See full story.

The core rate of the producer price index fell 0.4%, the largest drop since April 2003 and the first two-month decline since late 2002.

MarketWatch had expected the core rate to rise 0.2%.

The tame inflation reports fits into economists' expectations that the Federal Reserve will hold interest rates steady at 5.25% for the second straight meeting on Wednesday after 17 consecutive quarter-point rate hikes.

The odds of an increase in the overnight rate, as measured by fed funds contracts, lessened after the reports.

Peter Morici, a University of Maryland business professor, predicted there will be no change in monetary policy before the New Year.

In another piece of data that startled the market, the Commerce Department said housing starts fell 6% in August to a seasonally adjusted annual rate of 1.665 million, the lowest since April 2003. See full story.

Housing starts have fallen in six of the past seven months.

Building permits, meanwhile, fell 2.3% to a seasonally adjusted rate of 1.722 million, the lowest since August 2002. Permits have fallen seven months in a row, as builders adjust to a significantly weaker sales market.

"The market's [positive] reaction to the data is normal," said John Spinello, chief technical analyst at Jefferies & Co. "People might have been leaning the wrong way on Monday [when prices fell] and some short positions may have needed to be covered."

"Probably the more important number was the housing one, which showed dramatic deterioration," Spinello said.

"The inflation numbers were good for the market, but we already have seen that inflation is slowing," he said.

"Today's numbers won't be missed by the Fed either," said Kevin Giddis, managing director of fixed income at Morgan Keegan. "As they go into tomorrow's meeting, this type of data should make it easier for them on one hand and possibly disturb them on another."

"I don't believe the FOMC would have predicted such a fall in housing and could make a pretty good argument for the thought the Fed may have 'gone too far' in raising rates," Giddis said.

The news from Thailand also contributed to the Treasury rally. The Thai military surrounded the office of the prime minister with tanks, took over television stations and set up a so-called provisional authority loyal to King Bhumibol Adulyadej.

The prime minister is in New York to attend the United Nation's General Assembly.

"It contributed to the safe-haven bid,' said Kim Rupert, managing director of fixed income at Action Economics.

"The market moves higher higher on geopolitical concerns around the world," she said. "Whenever there's another uproar around the world, traders' first inclination is to make the safe-haven trade first and check it out later."

Laura Ostrander, who manages the Columbia Strategic Income Fund, called the events in Thailand "a wake-up call to investors."

"The Thai news is a reminder that politics do matter [to investments]," Ostrander said.

She pointed out that there were protests and turmoil throughout much of 2006 in Thailand which may have cut into growth there. However, at this time she is not expected major adverse economic impact from the coup in Thailand.

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